Market Volatility Bulletin: Support Is Now Resistance

Summary

• European equities are at two-year lows, and Treasury yields are plunging.
• With markets in flux, it is natural to study up on the market more; work hard not to misread the arguments of others.
• Russell acted as a volatility dampener during the summer; I see reversal.

Market Intro

CNBC: 1:42PM EST

S&P futures fared pretty well during the partial session yesterday, while markets rested in honor of the passing of former President George H. W. Bush, closing at 2718.

But as soon as today's pre-market began, futures were down handily. The CME had to halt trading on more than one occasion. US stocks (SPY, DIA, QQQ, IWM) have since bounced off their lows, but the damage is still quite real, especially as it follows on the heels of a gruesome Tuesday.

Spot vol has gone basically vertical over the last couple sessions. On Monday, the index tracked in the 16's.

CNBC

European equities (VGK, EEM) now trade at two-year lows. The US is off its highs of the year, but is still faring much better than other markets.

CNBC

Rates have positively dumped over the past couple weeks. It may well be the case that the drop in rates acts as reason for risk assets to rally, as the absolute level of rates makes the "TINA" argument more compelling.

Thoughts on Volatility

Famous bond fund manager Jeff Gundlach has a lot of personality, to put it mildly. Who knows what he actually has or has not said.

The larger point I'd like to make is this: particularly at points of stress, it is easy to stuff words into the mouths of others. At times like these, it is okay to have a view, but it becomes all the more important to listen objectively to others, mindful of the notion that we all come pre-wired with this erroneous paraphrase mechanism.

On that note, I think what Mr. Thrasher is trying to demonstrate is that the S&P 100-day moving average has now acted as resistance quite definitively on three separate occasions.

The line has not formally rolled over quite yet. But it's safe to say that traders might become quite skittish around that line from here on out. US stocks arguably have some substantial technical damage to repair.

I think the absolute spreads do matter for graphics like these. We're looking back to Feb '16 at the last true peaks, back when markets were going haywire. The spread range above is about 75 bps to 163 bps or so - a meaningful spread, but maybe not quite as dramatic as the graphic depicts.

2016 has been on my mind of late. Coincident economic indicators were worse around that time than now. But what there seems to be less of today is institutional support, coupled with broadly worse valuations.

Bond spreads were a part of the market drop back then, and it appears they are resurfacing as a threat to market stability today.

Term Structure

Look at that VIX9D! The indicator is telling us that this party is just getting started. If nine-day implied vol proves prescient, it will be difficult to launch a meaningful Santa rally.

I think there's a good possibility that the term structure does in fact loosen up here, likely with some upside bias if the VIX9D has the story right.

Roll yield is fairly steep in favor of vol longs at this time. It is worthwhile for those who are short vol (SVXY) to consider that not only is there currently a negative roll yield to contend against, but also the thrashing of futures can cause a rebalance decay.

It's way too early in my view to tap a short-vol play here, at least using straight ETP exposure, for any longer than a couple days.

2018 has been something of a "low-vol sandwich", where high volatility has been the characteristic of the beginning and ends of the year (UVXY), while low volatility prevailed between July and September.

Recall that the Russell and NASDAQ got on a real tear beginning in June and lasting through most of the summer. Tuesday's sizeable drop was led by Russell, and I opine at this time that Russell vol is going to pull up vol for the broader SPX.

Conclusion

If this is your first time reading Market Volatility Bulletin, thanks for giving it a try. If you're a regular, I thank you for your ongoing contributions in the comments section.

Be careful out there appears to have been sage words from the end of last Tuesday. What resonates most with me from A&H's message here is the theme of getting too heavily committed to a negative gamma position. When that trade stops working, he who panics first, panics best.

Thank you for reading.

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Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

I actively trade the futures and options markets, potentially taking multiple positions on any given day, both long and short. I also hold a more traditional portfolio of stocks and bonds that I do not "trade". I do believe the S&P 500 is priced for poor forward-looking returns over a long timeframe, and so my trading activity centers around a negative delta for hedging purposes.